Taxable Munis: “Best Value in Fixed Income”

By Randall Forsyth

As noted in this morning’s roundup, this has a boom year for corporate bonds as huge supplies of new issues have been met with strong demand. That’s despite historic low yields and tight spreads over benchmark Treasuries, which have investors hunting for values in bond land.

While that’s had traditional investment-grade corporate-bond buyers venturing into high-yield issues or mortgage-backed securities, Mark Grant, the managing director for taxable fixed income at Southwest Securities suggests a less-familiar alternative: taxable municipal bonds. As noted here on numerous times, the muni market has been staggered by the negative headlines from Detroit and Puerto Rico along with the seemingly never-ending outflows from municipal funds.

For those who can take advantage of tax-free income (such as most individual investors’ taxable accounts but not institutions such as pension funds), Grant says traditional munis are attractive now, adding “I would be stepping up my purchases before year end.”

For investors who don’t need tax-exemption, Grant calls taxable munis “the best value in fixed income at the moment.” As an example, he cites a long-term New Orleans general-obligation taxable bond (rated A3 by Moody’s and triple-B-plus by Standard & Poor’s), which traded at a yield of 6.12%–a spread of 2.35 percentage points over the Treasury long bond versus 1.12 percentage points for a comparable corporate. “That is a significant spread differential in my opinion and points out exactly why I like this segment of the market,” he writes in his “Out of the Box” daily missive distributed to the institutional elite of bond land.

Grant says there aren’t a lot of Build America Bonds (the taxable muni program backed by Treasury subsidies that ended a few years ago) or other taxable municipals around for institutional buyers. Individuals, meanwhile, have funds available to them to tap the sector relatively easily.

For the more adventurous, there are several closed-end funds specializing in taxable munis that have yields over 8% in some cases. To be sure, those yields are augmented by leverage, which has exacerbated their share-price declines in this year’s muni-market sell-off. The flip side is that the taxable-muni CEFs trade at double-digit discounts to their net-asset value.

For instance, the Guggenheim Build America Bonds Managed Duration Trust (GBAB) yields 8.68% at Friday’s share price, which represented an 11.73% discount from NAV, according to CEFConnect.com. That yawning discount is the result of an 8% decline in the share price, much steeper than the 1% drop in its NAV.